Leverage
| Mon Dec. 1, 2008 3:07 PM PST
LEVERAGE....Matt Yglesias approvingly notes something that Hank Paulson said today:
We need to get to the place in this country where no institution is too big or too interconnected to fail.
Hmmm. Is this even possible? Trying to regulate leverage is hard enough, but trying to directly regulate size and "interconnectedness"? Do we really want to do that?
Take AIG, for example. Was the problem that AIG was too big? Not really. The vast bulk of its business, after all, was in ordinary state-regulated insurance lines that weren't causing any problems. Their famous CDS losses were concentrated exclusively in the AIG Financial Products division in London, which employed a grand total of 377 people. The problem wasn't so much that AIG itself was too big, but that they allowed a small division to run amok.
(It's true that there's an indirect sense in which AIG's size allowed them to get into so much trouble: namely that CDS buyers trusted AIG's AAA rating so much that they didn't require them to post collateral. But that's pretty indirect.)
Beyond that, there's another problem: the world needs big banks. Large multinational corporations just aren't going to do their banking at a small community credit union, after all. They want to deal with a big money center bank that has plenty of lending capacity, expertise in a wide variety of areas, and branches around the world. You just won't find that in a small bank.
And then there's the interconnectedness problem. Bear Stearns wasn't really all that big (a fraction the size of Citibank, for example), but the Fed rescued them because they were afraid of cascading counterparty risk if they failed. Later they let Lehman Brothers fail, and they discovered that their fears were well founded. But how do you regulate that?
The modern world is a big place, and there's no way to turn back the clock. Big corporations and big banks are here to stay, whether we like it or not. Frankly, Paulson sounds to me like he's trying to mouth some feel-good words that he knows will never be taken seriously but make him look like he's getting tough on Wall Street. I'm not buying it. For my money, I keep coming back to the same thing: leverage, leverage, leverage. The key is to regulate leverage to reasonable levels and to regulate it everywhere. If it walks like a bank and quacks like a bank, then it's a bank and its leverage ratios should be regulated. That's what will keep banks from being too big to fail in the future, and this time around we shouldn't allow Congress or the SEC to toss off a few bland platitudes and then do nothing serious about it. Leverage is where the action is.
Continues Below
Continued From Above
Comments
Submitted by Carl Nyberg (not verified) on Mon Dec. 1, 2008 3:14 PM PST.
If the government had a graduated income tax that taxed income of larger corporations at a higher rate, it would create market forces to spin off pieces of the company.
Even as pie-in-the-sky speculation this makes no sense, and is predicated on the same simplistic thinking that got us into this mess.
Banks don't just fail in an uncorrelated way, as though they were independent random variables in some Probability 101 exercise. Rather they can fail in whole big bunches due to systemic problems either in the banking system or the economy as a whole. See "Depression, Great". Lots of small banks failed, adding up to one big mess. The same was true of the numerous financial panics of the 19th century.
To not understand this is to not understand business cycles and recessions. It's about systemic behavior, not uncorrelated random events.
In Keynesian terminology it's called risk (random uncorrelated failures) vs. uncertainty (it all hits the fan). IIRC that terminology didn't even start with Keynes, but he correctly placed great emphasis on the distinction.
You have a very weird definition of too big, but I am glad that small nuclear bombs have no power over you.
Paulson wants us to get to where banks are not too big to fail, which is why he gives them money, and encourages them to takeover other banks.
Yglesias figures out we need to break things up that are said to be too big to fail -- he's only about two months behind everyone else.
Jebus, it's like I need to be the nursemaid to the so-called progressive bloggers.
"(It's true that there's an indirect sense in which AIG's size allowed them to get into so much trouble: namely that CDS buyers trusted AIG's AAA rating so much that they didn't require them to post collateral. But that's pretty indirect.)"
That's indirect? Really? That seems pretty direct to me: it would have been impossible for the "small division to run amok" if the divisions required a lot of capital to post a lot of collateral on the CDSs it wrote.
Meanwhile, the point about leverage is understandable, but I don't know if it is right. Bear Stearns didn't have a huge jump in leverage over the past few years - 20% or so since 2003. What's the leverage ratio you think banks like Bear should have been at, Kevin?
Big corporations and big banks are here to stay
Actually, I don't think so, so this is another area that Kevin is dead wrong about.
Just like Hillary not taking the Secretary of State position, or Kevin's peak oil BS or that colossal monopolies are a fact of life. If indeed, we are headed into this very big depression every economist seems to be talking about, surely we can see that our inability to get around non-function corporate control is our biggest problem. It's been big oil buying up and hiding new energy patents, to automakers not interested in new technology, so that one can surely see the massive hindrance we face. It is holding humanity back in serious ways, this bailout shit is keeping us in dark ages.
Kev,
Not sure I agree completely, as the more assets you have, the bigger a hole you can create, but as alex points out, a whole lot of smaller institutions can do as much stupid as fewer larger ones. Not sure that could happen today with the amount of regulation we have, though.
There are several other reasons to keep the players small. One, it is easier to let them go bankrupt. Two, if limits the amount of money the officers can make. The point that keeps getting overlooked is that the officers of the financial institutions made hundreds of thousands of dollars running their companies into the dirt; that they get to keep, legally. I think they knew exactly what they were doing, but by the time the cows came home, they would be long gone with a monster Carribean bank account that didn't really care. Limiting the payout would reduce the magnitude of the ripoff.
I still don't think this whole thing is that complicated. They leveraged out the ying yang, paid themselves monster bonuses, accordingly, then dumped the whole thing in the government's lap to bail out. The complicated part was covering their tracks while they were robbing the treasury.
Just one giant con job.
Yves Smith commenting on an FT column (note her point -- contra Kevin -- about size in second paragraph):
"I strongly recommend reading the entire piece. One of her suggestions for regulators to focus on encouraging regional rather than national lending operations. Whitney stresses, as we have, that local/area knowledge is necessary for sound credit judgments; reliance on FICO scores has proven to be a disaster.
"Whitney does not call for breaking up big banks (and that would be more interventionist than anything on the table right now), but the idea that big banks are better has proven to be a canard. One of the key selling points, that bigger banks are more efficient, is utter baloney. Every study ever done of US banks has found that the industry has an slightly positive cost curve, meaning that costs rise as assets under management grow beyond a certain size threshold (some studies have found as low as $100 million, but the more common level is in the low-mid single digit billions). That means that all the cost savings achieved in mergers could have been realized by each institution separately.
So what has been the real impetus behind bank consolidation? Bank CEO pay is highly correlated with the size of the bank."
jerry: Yglesias figures out we need to break things up that are said to be too big to fail -- he's only about two months behind everyone else.
I know you're a big proponent of the "break 'em up until they're small enough to fail" approach. I agree that there are a variety of reason why too big isn't good. In particular because oligopolies reduce competition (e.g. bank mergers of the last decade lead to increased fees, etc., despite the supposed efficiencies of scale).
However, (see my 6:21) I don't think that's the key to preventing meltdowns. Historically we've had plenty of meltdowns even when most institutions weren't too big to let fail individually.
Obviously there's been a serious failure of regulation here, mostly related to (willfully?) forgetting the lessons of the past. Having already screwed up, the answer is to take failing banks into receivership rather than pursue Paulson's "bailout for my buddies" approach. Worked for the Swedes, and how bright can a bunch of blondes be?
Whether we have to take a few big banks into receivership or many small ones doesn't much matter. On the bright side when it comes time to re-privatize them there is nothing that says they can't be sold off in pieces (Citi1, Citi2, do I see a pattern?).
Beyond that, there's another problem: the world needs big banks.
Yeah, but how big does a bank need to be to be considered "big"? Clearly no bank should approach the size of America's GDP, like a lot of foreign banks do in their home countries.
http://www.bankersalmanac.com/addcon/infobank/wldrank.aspx
But below that should there be a limit? Maybe around 5% of GDP (~$700B). Or perhaps leverage ratios should be tied to size: over 1% of GDP - 10:1, over 5% of GDP - 8:1, etc.
Alex, the correct action to take is pretty much above my pay grade. I try to defer to Krugman.
I think Bob's point is right on target. A precise hit will start a chain reaction which should destroy the big bank. Just like shooting womp rats back home.
Would we let Citi/AIG/... form today or use anti-trust to keep them apart? If we wouldn't let them form, we need to break them apart now.
Break them up, it's for their own good.
The DOJ uses the HHI as a measure of bigness within a market.
Problem is determining what a market actually is. You might say that Budweiser has 70% of the domestic light lager market, and I can counter that they have less than .1% of the international beverage market.
No idea why you would apply that logic to banking.
For that matter, while I love progressive income taxes, doing so for corporate profits would create counter-incentives for pursuing economies of scale. Seems foolish in and of itself.
You're straining a bit about AIG in the course of making a valid point about leverage. AIG's size matters directly. That relatively small group of 377 people had an incredible amount of money to play with.
Potential payoffs to the greedy who controlled that organization were irresistible, to the point, as in so many places, where the managers were willing to be beguiled by complicated financial instruments without needing to understand, in their details, that the instruments were really BS in various ways.
You seem to be framing your argument against "big" Kevin, when Paulson is clearly talking about "too big" - i.e. big enough that a potential failure requires a bailout by taxpayers.
I couldn't agree more, and I've framed part of my arguments against promoting nuclear energy along similar lines lines, in these threads, a few years ago, though obviously those also included the potential blowback of a "failure" or "outlier" far more dangerous than an economic failure, as well as common sense liberal democracy notions that the more powerful you encourage private actors to become, the more influence they are able to buy over government, which often leads again to risky business down the road, along with the normal theft, inefficiency and so on that accompanies hubris and corruption.
Back to the main topic, "big" need not be measured in just the traditional "number of employees" sense, it can mean the amount you control, or the amount that is controlled that you are a main foundation and pillar of the risk or ownership portfolio for.
Following up on this, you could be small in land size, but huge connectively and resource-wise.
Think out of the box, which would also be required to really try and imagine really how to prevent "Too Big", which surely wouldn't be easy and perhaps actually not possible by liberal democratic means, other than just not encouraging and promoting it as we do now, erroneously and kinda foolishly if I'm going to be brutally honest about it.
Leverage is obviously important too, but we shouldn't ever be lulled into thinking that bigger and more powerful is better, usually it isn't, and leads to obvious and predictable abuses considering human nature and the nature of society and government.
All that said, I agree that leverage is a huge issue, one we must be much more vigilant about, along with very earnestly taking to heart the adoption of rock solid laws and regulations enforcing full and complete transparency and accountability.
It's amazing we really haven't done this yet as progressives, you hear it once in awhile, but it's never actually championed, when transparency, accountability, sunshine laws, the freedom of information is the lifeblood of liberty and democracy as we go forward into this awesome connected and technological future.
We can get it done, there's no reason to let the shucksters and jivesters at the top resist common sense rules and regulations anymore, especially common sense rules and regulations that strengthen the hand of the citizen, of the voter, of the family, against powerful interests that would buy their power and democracy from under them.
We do not need to let our society become a plutocracy (more than it has become). The existence of private enterprise is justified on the basis of "free" market economics, but the free market vanishes when there are only a few big players. The bigger a company the greater its influence on the government. People need to realize that it is increasingly necessary to make a choice between being ruled by corporate executives who are effectively responsible to no one, or by elected government. It has been realized in other countries that the power of corporations has to be curbed, but not in the US.
No, no, no. The banking system as presently constituted is wholly disfunctional. It doesn't 'have expertise in many areas ... that should be bloody obvious if you just pick up the financial pages. Banks have one job and one job only, to allocate capital efficiently. In the last decade the didn't quite do that ... but at least we got a lot of new technology out of the tech boom they financed. This decade all we got was a bunch of brown stucco tracts and great swaths of McMansions -- much of it built, at least in my part of the country, with cheap imported labor (said labors costs -- health, education for the kids, housing for US born kids) -- socialized as much as possible. So we not only got no positive gain from the multi-international conglomerate bank generated 'housing boom' -- we got negative externalities.
None of this would have happened had these expert-stuffed financial institutions dealt with homeloans like my credit union does.
Descentralize now! Local control! Smash the corporatist state!
The missing ingredient in this post is human nature. The free market generates superior outcomes because of decentralized decision making (amongst other things). An absolutely essential component of that is avoidance of failure. It leads, on average, to better decisions.
No matter how large the institution, it is never bigger than the thinking of its leadership. Allowing senior management to wallow in the luxury of "too big to fail" undermines healthy fear, while simultaneously preventing a better run firm from taking over from the poorly managed one.
As a rule, big companies don't adjust very well. They typically fade away or fail outright, and yield to better run, better adapted companies. Creative destruction. Introducing "too big to fail" shields exactly the wrong people. The better approach is to break up the failing firms by putting the pieces into the hands of successful businesses that will salvage the bits that are worth saving. Goverment's role should be to ease the collateral damage caused by these necessary free market transitions, not prevent the transitions before they start.
Although large corporations have accumulated huge wealth, most of their wealth has only been distrubuted amongst elites, and the incomes, goods and services they generate contributes very little to the living standards of the rest of the economy. Large corporations are considered too big too fail because the elite rulers' wealth is so closely associated with their financial viability. Most job creation in America, as well as economic growth, comes from small businesses. Saving the industries 'too big to fail,' is a form of Soviet-like corruption to save the living standards of the already wealthy at the expense of the rest of the economy.
dvw pretty much nails it. I recall discussions during the sixties and early seventies where some striking unions could cause a shutdown of the entire system and the claim was made that our society had become too interdependent and too vulnerable to the follies and whims of a relatively small group.
The essential problem is the conflict between the human need to accumulate power and the human need to spread out the power so we are not too interdependent or vulnerable to a small group.
Should we trust-bust now? Yeah. We should tax the ultra-rich, too. This will restore somewhat of a better balance, but the essential conflict will still remain and it will still cause problems in the future.
The http box is also a
Submitted by jewelry stores (not verified) on Fri Aug. 14, 2009 8:14 AM PDT.
The http box is also a search box, named the omnibox. so there is no plugin necessary for a search bar. just type your search in the address bar.
UGG Napoule Sandal discount
Submitted by UGG Napoule Sandal discount (not verified) on Sun Nov. 8, 2009 11:47 AM PST.
Tiffany Earrings replica
Tiffany Necklaces replica
Tiffany sets replica
Tiffany Accessories replica
UGG Gypsy Sandalv
UGG Matala Sandal
UGG Halendi Sandal
UGG Hammond Slipper
Breitling watches
Submitted by Breitling watches (not verified) on Fri Nov. 13, 2009 4:11 AM PST.
Concord watch for sale
Submitted by Anonymous (not verified) on Fri Nov. 13, 2009 8:27 AM PST.
Bell & Ross watch for sale
Breguet watch for sale
Breitling watch for sale
Burberry watches
Bvlgari watch for sale
Cartier watch for sale
chopard watch for sale
Concord watch for sale
croum watch for sale
DeWitt watch for sale
ebel watch for sale
Rolex Air-King replica Rolex
Submitted by Rolex Milgauss replica (not verified) on Fri Nov. 13, 2009 9:33 PM PST.
Rolex Air-King replica
Rolex Datejust II replica
xxx replica
Rolex Submariner replica
Yachtmaster replica
Rolex Day-Date II replica
Rolex Daytona replica
Rolex Explorer replica
Rolex GMT replica
Rolex Sea-Dweller replica
Rolex Day Date replica
Rolex Masterpiece replica
Rolex Milgauss replica
Rolex Milgauss watch for sale
Submitted by Rolex Milgauss watch for sale (not verified) on Tue Nov. 17, 2009 6:21 AM PST.
U-boat watch for sale
Vacheron Constantin watch for sale
Rolex watch for sale
Rolex Air-King watch for sale
Rolex Datejust II watch for sale
Rolex Datejust watch for sale
Rolex Submariner watch for sale
Yachtmaster watch for sale
Rolex Day-Date II watch for sale
Rolex Daytona watch for sale
Rolex Explorer watch for sale
Rolex GMT watch for sale
Rolex Sea-Dweller watch for sale
Rolex Day Date watch for sale
Rolex Masterpiece watch for sale
Rolex Milgauss watch for sale
